'Cap-and-trade' model eyed for cutting greenhouse gases

Published 4:00 am, Monday, December 3, 2007

In the 1980s, Washington policymakers faced an intractable problem: Acid rain, fueled by pollutants from coal-fired power plants, was ravaging lakes, streams and forests and endangering wildlife, especially in the Northeast.

President Ronald Reagan, siding with the coal industry and utilities, chose to study the problem. But when George H.W. Bush was elected president, he embraced a novel approach. He would allow power plant operators to buy, sell and trade credits to pollute - as long as they cut overall emissions in half.

"We will allow flexibility in how industry achieves these goals," Bush told lawmakers and business leaders gathered at the White House on June 12, 1989. "But we stand firm on what must be achieved."

Nearly two decades later, the acid rain program the Republican president crafted with a Democratic Congress - and over the opposition of many environmental groups - has emerged as the model for efforts to fight global warming worldwide. Europe's carbon trading market is based on it. California and other states are crafting their climate change rules on the same principles. U.S. senators are scheduled to vote in committee this week on a climate bill inspired by it.

Even opponents of the original measure, tucked into the 1990 Clean Air Act, now agree it's been a success. It has cut the emissions of sulfur dioxide by 40 percent from 1990 levels. By 2010, the Environmental Protection Agency estimates that complying with the law will cost utilities and consumers about $1 billion to $2 billion a year - about a quarter of what was originally forecast.

To supporters of climate legislation, the program is proof that "cap-and-trade" systems for greenhouse gases - capping emissions and allowing firms to trade credits to emit carbon dioxide and other heat-trapping gases - could achieve similar environmental gains and cost savings.

"The success of the acid rain program speaks for itself," said Sen. John Warner, R-Va., a chief author of the new Senate global warming bill.

But skeptics say the comparisons are exaggerated because any effort to limit greenhouse gases will be an order of magnitude bigger and more costly than the acid rain program.

While the acid rain initiative was focused on just one pollutant, sulfur dioxide (nitrogen oxides were later added), the new proposals seek to limit carbon dioxide and five other pollutants. The acid rain program focused on electricity producers, while the new efforts would affect utilities, large manufacturers and the transportation sector as well.

"With SO2 (sulfur dioxide), you are talking about one air pollutant, primarily from one industry, for emissions trading purposes," said William Fang, deputy general counsel and climate issue director for the Edison Electric Institute, a trade group for utilities. "With greenhouse gases, most of the bills are economy-wide or would focus on about 75 percent of the economy. ... You are talking about literally millions of sources."

The acid rain program began with a narrow scope: In 1995, emissions credits were allocated to 263 of the most-sulfur dioxide-intense generating units at 110 power plants, mostly in the Midwest and the East. The allowances to each unit were based on the plant's past emissions.

In 2000, the Environmental Protection Agency began the second phase, where nearly all power-generating units were forced to reduce their sulfur dioxide output or buy credits from plants that cut their emissions. Plants that miss the targets face stiff fines - $2,000 per excess ton.

At the time the legislation was being debated, many environmental groups were suspicious of the idea of a pollution credits trading program. Some dubbed it a "license to pollute."

"Many environmentalists were not at all enthusiastic about the idea of 'pay to pollute' ... even though most economists would say what we had before was people polluting for free," said Mary Nichols, chairwoman of California's Air Resources Board, who helped launch the program in the early 1990s as assistant secretary for air and radiation at EPA under President Bill Clinton. "It was something that just stuck in people's craw."

But a few environmentalists, led by the Environmental Defense Fund, now known as Environmental Defense, became convinced a market-based approach, combined with a firm emissions cap, could work. The idea gained favor while Bush was in the White House with then-EPA administrator William Reilly and other aides, who saw it as business-oriented solution to environmental problems.

Robert Hahn, who was a senior staff member for Bush's Council of Economic Advisers and helped draft the plan, said the administration ran simulations showing the program could cut emissions for half the cost of requiring plants to install new pollution control equipment.

"Politicians liked the idea of a concrete goal," Hahn said. "Economists liked the idea of a relatively cheap way of meeting the goal."

The key to the system was flexibility. The law let utilities choose which option was most cost-effective: They could buy new scrubbers, boost conservation efforts, switch to low-sulfur coal or buy credits.

"Under cap-and-trade, you can sell extra emissions credits to someone else - so you have an incentive to over comply," said Mark MacLeod, who works on climate issues for Environmental Defense. "That is very hard to reproduce with any other program."

Part of the acid rain program's success was good timing: The price of low-sulfur coal, which reduces emissions, was falling, which gave many coal-fired plants an easier way to trim their emissions.

"The sulfur dioxide program caught a wave and took advantage of some changes happening in the industry anyway," said Dallas Burtraw, a senior fellow at Resources for the Future, who has studied the program. "The really good news is the flexibility of cap-and-trade allowed sulfur dioxide regulations to take advantage of those changes rather than fixing in stone the kind of technology to be used."

Margo Thorning, senior vice president and chief economist for the American Council for Capital Formation, said the trouble with using the acid rain model to curb greenhouse gases is that many new technologies that cut emissions aren't ready yet.

"The technology did exist to control the components of acid rain ... without a huge cost," she said. "That is a different story when you talk about CO2. We don't have the technology right now to capture and store carbon from coal-fired power plants. ... So if we put in place a mandatory cap-and-trade program now, it will be extremely costly. We'll have to convert to natural gas, which is expensive now and will get more expensive, or we'll have to ratchet up plans to build nuclear power plants."

Supporters of new climate legislation say skeptics underestimate the pace of technological change. They say that setting a price for carbon - as the acid rain program did with sulfur dioxide - will spur innovations and help existing technologies such as wind, solar and geothermal power gain ground.

"One of the big lessons of the acid rain program is the rate of technological advance is affected by public policy - it can be accelerated or slowed down by public policy," MacLeod said. "The second lesson is that stability and predictability are key. That's one reason why taking a token climate change measure doesn't do anyone any good. If you know you're going to have to fix it five years later, you're not helping electric utilities and other emitters prepare for the future."

Europe's experience with its carbon trading market has been rocky. The European Union gave away too many allowances when the program started, so the price for carbon plummeted - reducing the incentive to cut emissions. Officials have been working to make fixes before the program's second phase begins next year.

"You can have a cap-and-trade program that accomplishes the goal of meeting the cap, but only if you design it carefully," said Nichols, whose staff plans to release a draft plan in June on how California's greenhouse gas cuts will be achieved.

The thorniest issue for regulators in California and elsewhere is whether to give away credits to emit carbon dioxide or to sell them. Some European power producers reaped windfall profits when allowances were given away. Several Northeast states are now moving toward auctioning all the allowances. California officials are considering a mix of auction and allocation - and even carbon taxes or fees - and may use different approaches for different groups of emitters.

Burtraw, who serves on a committee that's advising California regulators, said the lesson of the acid rain program is to keep the plan simple and easy for all parties to understand.

"If it starts to employ a lot of special provisions to take care of every party's special needs ... and if it starts to look like the Chicago phone book, then throw it out," he said. "A poorly designed market is worse than no market at all."

Model for climate change legislation

The federal Acid Rain Program, which limits emissions of sulfur dioxide and nitrogen oxides is seen as a model for new "cap-and-trade" systems to fight climate change in California and elsewhere.

Background: The market-based system, championed by President George H.W. Bush, was passed by Congress in 1990 as part of the Clean Air Act.

How it works: The law set a cap on emissions, and over time required electric utilities to reduce sulfur dioxide emissions by 50 percent from 1980 levels. It also created a pollution credit trading system. If a power plant cut its emissions below the cap, it could sell the credits to another plant operator that was having trouble meeting the cap.

Cost savings: The costs for utilities and consumers were less than half what they would have been if the U.S. Environmental Protection Agency had ordered all plants to install scrubbers, according to studies. The industry has praised the approach for its flexibility.

Environmental results: The program reduced sulfur dioxide emissions by 40 percent from 1990 levels and cut nitrogen oxide emissions to about half of what they would have been without the program. Acidified lakes and forests have shown signs of recovery.

Lessons for climate regulations: Greenhouse gas trading systems will be more complex and costly than the acid rain program, but analysts say a cap-and-trade approach could offer some savings for industry and consumers (although some economists favor a carbon tax as a more straightforward method). The trading systems must be easy to understand and transparent. A key question for regulators will be whether to give industry the allowances to emit greenhouse gases for free or auction them.

Source: Chronicle staff report

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